Combining Value and Earning Surprises for Outsize Returns

Below is another great study profile at cxoadvisory.com with regards to value stocks and positive earnings surprises. The study was conducted by Zhipeng Yan and Yan Zhao and CXO summarizes below:

Using stock price, earnings estimate and accounting data for a broad sample of firms over the period June 1984 through December 2008, they find that:

• Value stocks are less volatile than growth stocks around earnings announcement dates.
• Value stocks exhibit much larger positive drifts than growth stocks after positive earnings surprises and positive earnings announcement abnormal returns.
• Growth stocks exhibit much larger negative drifts than value stocks following negative earnings surprises and negative earnings announcement abnormal returns.
• A trading strategy that is long value stocks with both positive earnings surprises and positive earnings announcement abnormal returns and short growth stocks with both negative generates annualized size-adjusted returns of 16.6% to 18.8% (before trading frictions). Most of the return comes from the long side.

CXO concludes:

In summary, investors may be able to achieve abnormal returns by combining value and earnings surprises, with most of the benefit coming from value stocks with positive earnings surprises and positive earnings announcement abnormal returns.

How could an investor apply this in practical terms? A simple screen for value stocks with recent earnings surprises would be the easiest place to start. I used Zacks Premium screener for the screen below, primarily because they have the most robust screener I have used for earnings surprises.

In addition, I have further filtered the stocks to include small cap stocks (defined here as a market cap of less then $1 billion). There are rationals (such as here and here) for screening for small caps versus the entire market, but one could apply the value/earnings surprise theory to stocks of all sizes.

The screen criteria are below, along with the results using data collected at the end of last week:

• Last EPS Surprise (%) >= "20"

• Price/Book <= "1"

• Last Quarter's EPS >= "0"

• Twelve Month Trailing EPS >= "0"

• Avg EPS Surprise (Last 4 Quarters) >= "20"

• Previous EPS Surprise (%) >= "20"

• Average Volume (20 Days) >= "25000"

• Market Cap (millions) <= "1000"

The screen results:

Company Name	Ticker	Zacks Rank	Trend	Last EPS Surprise (%)	Price	Avg EPS Surprise (Last 4 Quarters)	Price / Book
INFINITY PPTY	IPCC	3	Here	46.94	39.11	62.65	0.9
CABELAS INC	CAB	2	Here	61.11	12.98	50.42	0.9
CELERA CORP	CRA	3	Here	100	6.3	733.33	0.87
AMER RAILCAR	ARII	3	Here	150	10.7	121.25	0.68
INFORMATION SVC	III	1	Here	900	3.52	433.33	0.85
ATLAS AIR WORLD	AAWW	3	Here	22.81	28.53	30.23	0.81
FIRST INDL RLTY	FR	3	Here	21.28	4.99	117.13	0.23
WINTHROP REALTY	FUR	3	Here	118.75	9.01	52.89	0.72
KADANT INC	KAI	1	Here	126.32	13.91	92.29	0.87
BANCORP BNK/THE	TBBK	2	Here	500	5.27	182.5	0.54
UTD AMER INDEMN	INDM	2	Here	153.33	6.85	53.83	0.51
OSG AMERICA LP	OSP	4	Here	250	10.2	150.21	0.37
SALEM COMM	SALM	N/A	Here	550	3.89	172.5	0.47
PARKER DRILLING	PKD	3	Here	300	4.98	145	0.96
PNM RESOURCES	PNM	3	Here	53.66	11.29	88.53	0.55
QLT INC	QLTI	N/A	Here	25	3.82	106.25	0.67
STARTEK INC	SRT	4	Here	20	5.89	68.39	0.76
SUSQUEHANNA BSH	SUSQ	3	Here	175	5.5	71.33	0.28
KINDRED HLTHCR	KND	3	Here	400	15.5	128.07	0.64
WILMINGTON TRST	WL	4	Here	171.43	12.97	127.86	0.91
REGIS CORP/MN	RGS	2	Here	38.1	15.99	32.61	0.92
KIMBALL INTL B	KBALB	N/A	Here	166.67	7.25	116.03	0.7
SHOE CARNIVAL	SCVL	2	Here	300	15.33	63.13	0.94
WESTELL TECH-A	WSTL	4	Here	33.33	1.18	66.67	0.98

Author's Disclosures: no positions

Source: Combining Value and Earning Surprises for Outsize Returns